Tools & Resources

For all the discussion about the Affordable Care Act (ACA), it's still tough to cut through the clutter of politics and spin. Even the law's name breeds confusion.

Consider a recent CNBC poll that surveyed two separate groups. In the first group, 37% opposed ACA, while 22% favored the law; less than 60% of respondents expressed an opinion. The survey posed the same question to a second group but switched the wording to Obamacare, a term embraced by President Obama during the last election. In this instance, 46% disagreed with the law and 29% favored it, a response rate of 75%.

AFFORDABLE CARE ACT A TAILWIND FOR HEALTH STOCKS

---------- Median Share-Price Change Since . . . ----------

S&P 1500 Industry (No. Of Cos.)

Congress
Passed
ACA 3/22/10
(%)

U.S. Surpreme
Court Upheld
ACA 6/28/12
(%)

End Of
2012
(%)

Launch
Of ACA
Exchanges
10/1/13
(%)

Biotechnology (14)

88

50

46

3

Health Care Distributors (8)

73

40

34

8

Health Care Equipment (37)

38

30

24

7

Health Care Facilities (10)

73

56

42

6

Health Care Services (19)

28

29

23

0

Health Care Supplies (9)

88

25

34

5

Health Care Technology (8)

56

48

54

3

Life Sciences Tools & Services (14)

49

52

42

3

Managed Health Care (10)

93

41

38

0

Pharmaceuticals (22)

88

37

42

3

S&P Health Care Median (151)

52

39

34

4

S&P 1500 Index Median (1,500)

53

33

24

4

The massive law features many moving parts, with some changes launched in 2011. Perhaps the most divisive piece, the individual mandate requiring all Americans to carry health insurance or pay a fine of up to 1% of household income, begins Jan. 1. Employers must offer insurance to workers by 2015.

No one knows if this law will work. It saddles healthy Americans with the burden of subsidizing the astronomical costs of care. Other parts of the economy could suffer if the higher insurance rates cause younger Americans, many already buried in college debt, to delay buying homes and forming households. And what happens to ACA if the healthy opt to pay the fine rather than the insurance?

DRILLING INTO S&P 1500 HEALTH INDUSTRIES

Median
Trailing
P/E Ratio

Median 12-
Mo. Change

Median
Est. 12-
Mo. EPS
Growth
(%)

------ Median Quadrix Scores ------

S&P 1500 Industry
(No. Of Cos.)

EPS
(%)

Sales
(%)

Momen-
tum

Value

Quality

Overall

Biotechnology (14)

33

5

11

13

39

22

95

54

Health Care
Distributors (8)

21

8

1

11

55

59

64

63

Health Care
Equipment (37)

21

10

7

8

44

48

74

54

Health Care
Facilities (10)

18

8

6

14

48

65

65

57

Health Care
Services (19)

19

7

6

10

56

60

69

70

Health Care
Supplies (9)

23

16

9

9

59

41

73

49

Health Care
Technology (8)

27

13

15

10

67

27

85

73

Life Sciences
Tools & Svcs. (14)

24

12

1

11

57

40

70

53

Managed Health
Care (10)

15

16

13

8

61

68

74

76

Pharmaceuticals (22)

17

5

4

10

40

48

66

49

S&P Health Care
Median (151)

20

9

7

10

52

49

73

58

But the current system isn't working, either. Health costs account for 18% of U.S. gross domestic product — no other developed country exceeds 12%. With 10,000 baby boomers turning 65 each day over the next decade, health costs are expected to approach 20% of GDP by 2021.

As for the effects of the ACA on individual health industries, a common theme emerges: Volumes should rise, though the new business comes at the cost of heavier regulation and lower reimbursement rates. Below, we take a closer look at the effects of the ACA on key industries, and thus on our recommended health stocks.

Managed health care

Aside from hospitals and other health providers, managed-care companies will bear the most exposure to the ACA.Â On Oct. 1, the U.S. launched state-based exchanges where individuals can buy standardized health-care insurance. Heavy customer volume and software problems have crippled the 34 federal exchanges, but the 14 state-run exchanges run more smoothly. As of Oct. 20, about 500,000 people had applied for coverage. Enrollment remains open through March, and the benefits don't begin until January, allowing some time for administrators to smooth out technical glitches.

Insurers should see mixed benefits from the exchanges. About 7 million of the 50 million uninsured in the U.S. are expected to enroll this year. By 2017, rolls could swell by 25 million new people. Yet new regulations will cut into insurers' profit margins. The exchanges present policy details in a standard format, hoping transparency will stoke competition.

Most insurers have approached the exchanges with caution, none more so than Cigna ($76; CI), which participates in just five state exchanges: Arizona, Florida, Tennessee, Texas, and Colorado. Most exchanges have two to six insurers in each state, though some feature as many as 13. Earlier this month, UnitedHealth ($69; UNH) said its insurance plans vary widely between regional exchanges, based on competition and the size of the network. The company also warned that 2014 earnings â€œwill likely straddleâ€ its 2013 guidance of $5.40 to $5.50 per share, partly because of planned reductions in government funding for Medicare Advantage and other provisions of the ACA.

Cigna has yet to provide an estimate of the effects of health reform on its operating results. About 30% of its premiums and fees come from U.S. commercial plans. Roughly 26% comes from U.S. government plans, boosted by the $3.8 billion acquisition of HealthSpring in January 2012. More than 90% of Cigna's U.S. commercial members work at midsize or large companies, limiting exposure to the exchanges. An estimated 95% of U.S. companies with more than 50 workers already offer health benefits.

ACA caps insurers' profits on premiums collected from underutilized health plans. In 2011, the U.S. rolled out a minimum medical loss ratio (MLR), requiring comprehensive medical plans to spend a minimum percentage of a premium — 85% for large groups and 80% for small groups and individuals — on health care. Insurers must return premiums in excess of that level to policyholders through rebates. This mandate applies to about 20% of Cigna's commercial customers.

Managed Health Care

Company (Price; Ticker)

Advice

Aetna ($64; AET)

A (above avg.)

Cigna ($76; CI)

LT Buy

UnitedHealth ($69; UNH)

B (average)

WellPoint ($88; WLP)

A (above avg.)

Biotechnology/drugs

Drugmakers have paid annual fees for ACA since 2011 while offering 50% rebates on branded prescription drugs sold to patients under Medicare Part D coverage. At this point it's uncertain whether volume gains will offset the cost.

Like traditional drugmakers, biotech companies face pricing pressure and lower reimbursement rates from insurers. But ACA should also boost prescription-drug volumes, since many patients requiring regular medication could quickly use up their drug deductible, expected to average $250 a year.

Makers of generic drugs, such as Mylan ($39; MYL), are poised to enjoy greater benefits than their branded peers. Health reform leaves hospitals and other industry players scrambling for ways to eliminate costs. An obvious option is switching to generic drugs from pricier branded versions. ACA also paved the way for generic versions of biotech drugs, which are generally produced in living cells. So far, no generics have yet been approved but these so-called biosimilars could eventually hurt Celgene ($161; CELG) and help Mylan.

Biotechnology

Company (Price; Ticker)

Advice

Amgen ($116; AMGN)

B (average)

Biogen Idec ($251; BIIB)

A (above avg.)

Celgene ($161; CELG)

Buy *

Gilead Scien. ($68; GILD)

B (average)

Pharmaceuticals

AbbVie ($49; ABBV)

B (average)

AstraZeneca ($52; AZN)

B (average)

Bristol-Myers ($50; BMY)

C (below avg.)

Eli Lilly ($50; LLY)

B (average)

Hospira ($42; HSP)

C (below avg.)

John. & John. ($92; JNJ)

B (average)

Merck ($46; MRK)

C (below avg.)

Mylan ($39; MYL)

Focus Buy *

Novartis ($78; NVS)

C (below avg.)

Novo Nordisk ($180; NVO)

B (average)

Pfizer ($31; PFE)

C (below avg.)

* Also a Long-Term Buy.

Device/equipment makers

Growth prospects from ACA appear smaller for device makers. They should benefit from an increase in elective procedures, such as knee replacements. But most surgeries are acute-care procedures that would occur regardless of the law.

Unlike other health industries that pay a flat fee under the ACA, the U.S. charges makers of medical devices a 2.3% tax on equipment — such as magnetic resonance imaging (MRI) machines, heart valves, or pacemakers — sold in the U.S.

Republicans briefly took up the industry's cause, pushing to repeal the tax during the debt-ceiling standoff. At the time, the White House said it would consider the proposal after Congress agreed to raise the debt ceiling. But this issue could become a slippery slope, encouraging other health industries to rethink concessions they accepted in order to help fund ACA.

The Congressional Budget Office estimates the excise tax could cost the medical-device industry more than $30 billion over 10 years. Stryker ($74; SYK) expects to owe $100 million from the tax this year, while Johnson & Johnson ($92; JNJ) could pay up to $300 million. Both figures dwarf the tax hit for the smaller Varian Medical Systems ($77; VAR).

So far, Varian's expenses from the excise tax totaled just $5 million in the six months ended June, and the company projects $3 million for the September quarter. Varian's September-quarter results are reviewed in Portfolio Review.

Varian has seen a reduction in customers' capital spending, which it blames on uncertainty over ACA and lower reimbursement rates for oncology treatments. The current Centers for Medicare and Medicaid Services proposal for 2014 reimbursement rates calls for an increase at hospitals, especially for new and efficient treatments, which bodes well for Varian.

Device/equipment makers

Company (Price; Ticker)

Advice

Abbott Labs ($37; ABT)

B (average)

Baxter Int'l ($65; BAX)

B (average)

Covidien ($64; COV)

B (average)

Medtronic ($57; MDT)

A (above avg.)

St. Jude Med. ($56; STJ)

A (above avg.)

Stryker ($74; SYK)

B (average)

Varian Medical ($77; VAR)

LT Buy

Zimmer ($88; ZMH)

A (above avg.)

Services/distributors

Pharmacy-benefit managers (PBMs) such as Express Scripts ($64; ESRX) and CVS Caremark ($61; CVS) could be among the biggest winners of ACA. PBMs keep costs down by purchasing drugs in bulk. They steer patients toward less-expensive options, specifically generic drugs, in the process helping their own operating profit margins. In an industry where scale matters, PBMs should see higher prescription volumes.

Express Scripts says 2013 has been one of its best retention years ever, with few clients changing PBMs ahead of health reform. The company draws 14% of its revenue from WellPoint ($88; WLP) and 9% from UnitedHealth. WellPoint's big presence in public exchanges bodes well for Express Scripts. UnitedHealth could prove more problematic; the insurer said its base of commercial members will shrink next year after the migration to private exchanges.

Private exchanges could shake up the market, forcing PBMs to lower their prices. In September, Walgreen ($59; WAG) announced plans to move 160,000 employees and family members to a private exchange. Separate from the ACA exchanges, these private marketplaces reduce costs for employers and provide better visibility on these costs by shifting the health plans to â€œdefined contributionâ€ rather than â€œdefined benefits.â€

Cigna participates in two of the four largest private exchanges, UnitedHealth participates in three, and WellPoint in all four. The move to private exchanges could shift market share for PBMs depending on which employers switch, but the effect on earnings will likely be small in the near term.

While fewer than 1% of active workers participate in private exchanges, interest is high; recent surveys suggest 40% of employers are considering private exchanges. By 2018, 25% of the U.S. population could be on private exchanges, estimates Accenture ($69; ACN).

Your subscription to Dow Theory Forecasts comes with a Money-Back Guarantee. If at any time you are not completely satisfied, simply let us know and we will cancel your subscription for any reason. Any issues, special reports, or bonuses you have received are yours to keep. We will cancel your subscription and promptly refund any paid, unmailed issues.

If you have any questions or problems, please contact our dedicated customer service staff for assistance via e-mail at custserv@horizonpublishing.com or by calling 800-233-5922.

* You must be a current active subscriber to Dow Theory Forecasts to access our special subscribers-only features.

Dow Theory Forecasts® is a publication of Horizon Publishing Company
7412 Calumet Avenue
Hammond, IN 46324
800-233-5922
Quadrix® is a Registered Trademark of Horizon Publishing Company
* Charts by MetaStock®. MetaStock is a registered trademark of Equis Int'l..